Financial Accounting Chapter 7 Notes Cash and Receivables

Transcription

1 Financial Accounting Notes Cash and Receivables I. Management Issues Related to Short-Term Financial Assets Management of short-term assets is critical to providing adequate liquidity. In dealing with short-term liquid assets, management must address three key issues: 1. Managing cash needs during seasonal cycles 2. Setting credit policies 3. Financial receivable. Setting Credit Policies: Companies sell on credit to be competitive and to increase sales. The credit department is responsible for the examination of each person or company that applies for credit. To measure the effect of a company s credit policies two ratios are used: 1. Receivable Turnover Reflects the ability of the company to collect on their accounts. This ratio consist on one income statement account and one balance sheet account Note: Turnover Ratios consist on an Income Statement Account and a Balance Sheet Account Receivable Turnover Example: Net Sales Average Net Accounts Receivable $2,175,236,000 ($430,825,000 +$390,740,000)/2 5.3 times This company turns its receivables 5.3 times a year. 365 days Average Days Sales Uncollected Receivable Turnover 68.9 Days In-class SE-2 The company turns its receivables 5.3 times every 68.9 days. Comparing this result with industry averages will allow you to evaluate the results. Financing Receivables: 1

2 Receivables tied up the funds of a company. Some companies may decide to sell those receivables to obtain cash. This is done by: 1. Work with financing companies to help their customers finance the purchase of their products. EI. Automobile companies, Ford Motors, Best Buy etc. 2. Factoring: Transferring (selling) their accounts receivable to another entity (called factor). Two methods: Without recourse: All liabilities passes to the company that buys the account. With Recourse Liability for the account remain with the seller of the account. 3. Contingent Liability: Companies that sell their receivables with recourse have a potential liability that can develop into a real liability. 3. Discounting: Selling of promissory notes held as notes receivable. It is call discounting because the bank deducts the interest from the maturity vale of the note to determine the proceeds. With discounting the bank that buys the note will collect the principle plus the interest. If the principle is not collected then the company who issue the note is liable to the bank. II. Cash and Cash Equivalents Cash Currency, coins, checks, money orders, compensating balance, impress accounts (petty cash). (Compensating balance is the minimum amount that some banks may require to keep the account open.) Cash equivalents Money deposit in a bank or other financial institution for less than 90 days. Because the amount is converted to cash so fast are regarded as cash. Such as Treasury notes, or CD s. Cash equivalents are always recorded at cost. In-Class Exercise: SE3 III. Accounts Receivables Accounts receivable are short-term liquid assets that arise from sales on credit to customers by wholesalers or retailers. Some receivable accounts will default. Usually a company keeps track of the receivables that are not collected. Based on this history, a company calculate a historical percentage of what they is the typical default rate. There are two methods of accounting for uncollectible accounts receivables: 2

3 1. Direct Charge Method Accounts that are not paid during a period of time are written off. However most companies do not use this method because it does not conform to the matching rule as to when revenue (accounts receivable where charged) and when is expensed, (when receivables are written off). However, many small companies use it because it is required in computing taxable income under federal tax regulation. 2. Allowance Method Most prefer method because it matches revenues with expenses. In this method, management estimates a percentage of the total amount of accounts receivable that will be uncollected, and the estimate becomes an expense in the fiscal year in which the sales were made. To remember Questions: What does Written Off mean? To expense it. Where does the Uncollectible Account Expense is recorded? Income Statement What type of account is the Allowance for Uncollectible Accounts? Contra Account of Accounts Receivable Where does the Allowance for Uncollectible Accounts Appeared? The Balance Sheet Calculating Uncollectible Accounts under various methods. (Study) Percentage of Net Sales Method: The Percentage of net sales method asks the question, how much of this year s net sales will be collected? Calculation of net sales (Sales Sales Returns and Allowance Discounts) Based on History the following chart was prepared: Year Net Sales Losses from Uncollectible Accounts Percentage 2006 $520,000 $10, ,000 13, ,000 9, Total $1,700,000 $34, Management will use 2% to forecast uncollectible accounts receivables 3

4 Example, using above data. Net Sales = 600,000 x 2% estimated uncollectible = $12,000 Dec 31 Uncollectible Account Expense 34,000 Allowance for uncollectible accounts 34,000 In-Class Exercise: SE5 Allowance for Uncollectible Accounts Dr. Cr. Beg. Bal. 3,600 Dec ,000 Dec. 31 Adj. 13,600 Aging Method: Looks at every account open and establishes a percentage based on time. Example: At year end a company prepares an aging schedule. My Company Analysis of Accounts Receivable by Age December 31, 2002 Customer name Total Not Yet due 1-30 Days Days A. Arnold M. Benoit J. Conolly 1, Days Over 90 days R. Deering Others 42,600 21,000 14,000 3,800 2,200 1,600 Totals $44,000 $21,900 $14,250 $4,200 $2,450 $1,600 Estimated % uncollectible Allowance for Uncollectible Accounts $2,459 $219 $285 $420 $735 $800 The uncollectible accounts expense is recorded as follows: Dec. 31 Uncollectible Accounts Expense $1,659 Allowance for Uncollectible Accounts $1,659 4

5 The total $1,659 written off is calculated as follows: Allowance for Uncollectible Accounts Dr. Cr. Beg. Bal. 800 Dec. 31 1,659 Dec. 31 Adj. 2,459 In the aging method we must see what is the balance in the allowance for uncollectible accounts and we must subtract that number with the target balance. EI: Target balance (after aging the accounts) $2,459 Beginning Balance 800 Uncollectible accounts expense $1,659 In-Class Exercise: SE6 Memorized the following Journal Entries: Writing off uncollectible accounts: Jan. 15 Allowance for Uncollectible Accounts $250 Accounts Receivables $250 (To write off receivables as uncollectible) Recovery of accounts written off. Sep.1 Accounts Receivable $250 Allowance for Uncollectible Accounts $250 (To reinstate for Uncollectible Accounts) Sep.1 Cash $250 Accounts Receivable $250 In-Class Exercise: SE7 V. Notes Receivable Notes receivable are promissory notes to pay a definite sum of money on demand or a future date with a interest payment. This situation may arise as an agreement from a credit customer. This customer may rather establish a promissory note and pay interest that face bad credit report and the inability to shop with that vendor again. 5

6 Computation of a promissory note at Maturity Date What must be known before recording? (1) Maturity Date -> is the date the note must be paid (2) Duration of Note -> the length of time in day between a note and its maturity. (3) Interest and interest rate (4) Maturity value Example: June 1, A 30 day 12% note $4,000 principle Issue of a Note Receivable: June 1 Notes Receivable $4,000 Accounts Receivable $4,000 (Received a 30 day 12% promissory note) Payment of a Note receivable one month after July 1 Cash $4,040 Notes Receivable $4,000 Interest Income 40 Preparing the adjusting entry for a promissory note at year-end. Dec. 31 Interest Receivable Interest Income (To accrue 30 day interest earned on a note receivable $2,000 * 8% * 30 / 360 = 13.33) Payment of Note plus interest: Oct. 31 Cash 2, Notes Receivable 2,000 Interest Receivable Interest Income (To accrue 30 day interest earned on a note receivable $2,000 * 8% * 30 / 360 = 13.33) In-Class Exercises: SE8 and E12 Homework Assignments for : E4, E5, E7, E8, E9, E13, E14. 6